MILLIONS could get a £1,000-a-year pay rise under plans to scrap income tax on the state pension.

Chancellor George Osborne is being urged to ditch the levy by the Office of Tax Simplification, an independent advisory body he set up.

The proposal, which would mean five million pensioners sharing a £5billion bonus, was given a warm welcome last night.

Neil Duncan-Jordan, of the National Pensioners’ Convention, said: “This would be popular with many. It does annoy people that they feel they are getting taxed on something that they have contributed to all their working lives through the tax system.

“The alternative would be to increase the personal allowance to take pen- sioners out of tax altogether.

"Either way, pensioners would welcome recognition of the contribution they have made.” Ros Altmann, director-general of Saga and a former Government pension policy adviser, also welcomed the proposal.

Either way, pensioners would welcome recognition of the contribution they have made

Ros Altmann, director-general of Saga

“The thrust of policies in recent years has been to take money away from pensions,” she said. “The Government seems to see pensioners as a valid target for taking money, pa rticularly middle-income pensioners.”

John O’Connell, research director at the TaxPayers’ Alliance, called for the measure to be included in a wider overhaul of the tax system.

He said: “It’s good that the Office of Tax Simplification is trying to come up with ways to simplify the tax system, but they’ll keep coming up short unless we significantly overhaul it. We have to be far more radical if we want a system that is fit for purpose.”

Mr Osborne is likely to face pressure to include scrapping tax on the state pension in the run-up to his Budget on March 21. But he would have to find an extra £5billion from spending cuts or tax rises elsewhere to fund the measure, at a time when the Government is trying to reduce a record Treasury deficit.

In its interim report, the Office of Tax Simplification said fewer than half of all pensioners realised their state pension was liable for income tax in the same way as salaries.

It added: “Many of those who do understand feel that this is unjust, given that they have contributed through the national insurance system throughout their working life.”

Figures from Revenue & Customs suggest that around 5.6million people receiving the basic state pension pay income tax. They are frequently pushed over the threshold by private pension income and savings interest.

A full basic state pension is worth £5,311 a year. Scrapping the 20 per cent tax would be worth around £1,060.

Pensioners are already exempt from paying national insurance contributions. They also have a higher tax allowance than younger people, with the threshold for those aged between 65 and 74 set at £9,940. The threshold for working-age people is £7,475.

John Whiting, tax director for the Office for Tax Simplification, said: “Too many people find the tax system gets more complex as they get older.

“Our report floats a number of possible ways to mitigate the difficulties pensioners face. We haven’t shied away from the big issues and I hope that this interim report helps stimulate a debate on pensioner taxation.”

A Treasury spokesman said ministers would respond to the report in the Budget.

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